17 May 2013, 1:24pm
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  • The trouble with a HYP strategy now is everyone else is trying it too. Cash is still evil…

    A few years ago I decided to follow a HYP strategy. I read this, and in particular I liked

    But there’s a way of profiting from holding shares that requires no selling at all, by receiving the (generally) twice-a-year dividend.

    So I did it. And am still doing it. It gives me a yearly yield of 5% p.a. on my purchase cost and capital appreciation which more than compensates for inflation, indeed at the moment this is faintly ridiculous. That is due to the disgraceful activities of the Bank of England flushing away the national debt by debasing the currency combined with some hint of animal spirits returning to the business world. So far so good. I have two problems now, both good ones to have in some way.

    A HYP is not the approach to take at the moment because everyone else is doing it

    This doesn’t hurt what I have already, because the yield I earn is the yield on the price I paid. The problem is everyone else is bidding up the price of the shares so it makes it harder to find value.Some would advocate taking the profits and trading the portfolio but I’m not going to do that because this is not how a HYP is meant to work and I have no skill as a medium term trader ;) I will sit on my backside and take the divi, indeed I have managed to avoid selling anything this year other than that mandated by iii’s change in funds policy.

    A first approach is to look for diversification in areas that are out of favour – I have no oil or mining stocks and could do with some for sectoral diversification. Both of these sectors haven’t been on the roll that everything else seems to have been on this year. I also don’t have the religious objection to tobacco many people have either. I’ve avoided all these sectors because I don’t understand them and when I constructed my HYP they were highly valued. If there were a sector index fund on these areas I’d consider going that way.

    However, at the moment I am suffering from a combination of RDR paralysis and the fact that everyone else seems to be destroying the opportunities in what used to be a quiet and tedious investing backwater in a search for yield. So maybe it is time to sod off and fish is some quieter backwaters.

    The FSCS compensation issue

    The second is that my ISA will cross the FSCS compensation threshold this year even if I leave it alone, and it will cross it sooner if I contribute this year’s 11k allowance. Even worse is that I have about half as much again in an unwrapped TD account, which I used to flush out my sharesave and ESIP holdings. I didn’t want a large unbalanced holding of The Firm’s shares so I took a share certificate for half the holding, which I will sit on and take the dividend thanks very much. The other half I moved to TD, and sold some to crystallise capital gains, which I converted into a Vanguard developed world exUK index fund and a Vanguard EM index fund. I have more than enough UK exposure in my ISA, so the Dev exUK was to balance that out a bit, but the aim of the exercise was mainly to cut down the exposure of having half my shareholdings in The Firm.

    A share certificate is a good way round the FSCS issue – I have a direct holding in The Firm and there is no nominee intermediary to worry about. However, you can’t hold an ISA that way so I have to deal with nominee accounts. Having both ISA and regular nominee accounts with TD was a tactical mistake I didn’t appreciate at the time. The FSCS compensation applies to each company, not each account, so I am already way over the top. The obvious thing to do is to move the trading account.

    However, at the moment there is loads of confusion in the UK shareholding nominee platform arena due to the change in regulation of funds, called the RDR. I have already taken one hit from the RDR last year. For this year I am going to sit tight, accept the risk of TD Direct going wrong, which I think is low. If there is general stock market mayhem in some ways the FSCS compensation limit of £50k is self-correcting, as a jolly good stock market crash will automatically devalue the holding – a serious market crash can halve the value of a portfolio in a year which would get me below the protected amount. So TD going bust due to a stock market crash isn’t the problem, it is them going bust due to an internal thief or management incompetence. I should add that I have no reason to currently suspect either, I’m not saying that they are a bunch of incompetent fools, I am merely considering the risk ;) We have seen in 2008-9 that financial institutions that look solid are often built on sand these days…

    Cash is evil…

    Still a particularly rotten asset class. It makes me sore that my AVC fund is in cash because I will pull it in about year from now. The Bank of England’s destruction of the pound will have rotted the real value of that by about 10% compared to when I left work. Okay, so I avoided paying 40% tax on it, so in the round I am still better off than where I started, but that needs to come out and start working for me.

    I also hold cash because at the moment I am living off savings and that is decaying under my feet. This was highlighted recently when a three-year NS&I Index-linked savings certificate rolled over. It started out a £1000 and rolled over at £1,162, ie in three years the value of money has fallen by 16%. I at least have the benefit of being so poor (okay, hold on the strings and violins in the background, guys) that I don’t pay income tax this year and next, so I filled in my form R85 when I switched my Nationwide Flexaccount to a Flexdirect account. They will give me 5% on £2000 if I play stupid games shifting £1000 back and forth between that and my main bank account each month. With R85 I get to see 5%, too ;)

    Zopa

    I also joined Zopa, though unlike others I consider this bordering on mortgage-backed securities in terms of risk, so I only put into it an amount that I can afford to lose 100%. To see what’s wrong, we only have to look at the current case study.

    And borrower Jonathan is no exception – he used his loan to buy a splendid engagement ring for Charlotte, his girlfriend of 8 years

    Jonathan, me old bean, you have been with this lady for 8 years, and you’re getting married. I’m really happy for you and wish you a long and happy married life. However, despite it making me look like a hard-bitten unromantic old git, a quick word in your shell-like.

    Is it really such an illustrious start to your married life to go into debt for the ring, which is a consumer item, this isn’t an asset that reduces your long-term costs or makes you money?

    My father saved to buy my mother a ring. My grandfather did for his wife. Getting married is a very large transition in your life, and doubly so on the financial front if you are planning to have children. You really, really, don’t want to go into debt for any aspect of getting married. If debt is the answer, you can’t afford to get married, or your wedding plans are too extravagant 1. Save up for the expense, because, to be honest, if you do end up having kids, this point is probably about as good as it gets for a little while on the disposable income front. So, Jonathan, if you are borrowing to buy her a ring, particularly after having had 8 years to get ready, then you have just passed a great big red “Wrong Way, Do Not Enter” sign. And you, sir, need to sort your financial shit out and understand the simple principle. If it’s a consumable item, never, ever, borrow money to get it unless it saves you money. A house is a consumable item – the only reason you go into debt for it is because it stops you paying rent 2. Now what is the ongoing cost that Charlotte’s ring is saving you paying out every year? Zilch, thought so. So you need to man up and save for that sort of thing in future. Or do without.

    What Zopa needs is an ermine behind a leather-covered desk with a banker’s lamp on it. When people come in to borrow money, the ermine will ask them some pertinent questions about what they are going to buy with it, to the effect of:

    How to decide if borrowing money to buy it is a good idea

    How to decide if borrowing money to buy it is a good idea

    It’s notable that this accounts for something that we are very reluctant to acknowledge in the developed world today. That sometimes people have needs that they cannot afford. I have had the experience, and it’s a bastard. But it isn’t necessarily up to Them to fix that for you, sometimes you have to spit on your hands, roll up your sleeves and get to dealing with the issue at hand. Or, heaven forbid, do without some Wants so you can afford your Needs…

    The decision process for purchase of consumables would be slightly different if I were working for Zopa, because it would come down to whether I believe this punter is fool enough that I can get the money out of him with my heavies as opposed to the heavies used by the other guys he’s likely to borrow money from. However, though Zopa try and make out all cuddly with their Valentine story and all smoochy smoochy aaah ain’t it luvverly, in the end they are highlighting a fellow who shouldn’t be using Zopa for that purchase. Not because it’s inherently and deeply wrong for him to borrow money to buy his girlfriend a ring, rather than, say, a motorbike, or a holiday, because at least the ring is durable and hopefully gives them joy for years to come. But because he should have been saving for it over the previous 4-8 years, after all it was a reasonably foreseeable expense. Put another way, Jonathan has just chosen to buy £85 worth of ring for £100, because he wasn’t able to foresee this purchase, and he’s paying 5% over 3 years for the pleasure of not looking at the road ahead.

    Now if their disposable income is always going to be more than their living costs then so what, I have addressed that option in the decision tree. I have borrowed twice in my life to buy a consumer durable.  The first time was the wisest, though it didn’t look that way. When I started work and was living at home I borrowed 20% of my gross income to buy a secondhand preamplifier, on 0% interest free credit. I paid every instalment from income, just before time, and recently I had to fix this preamplifier – it is still in service after 30 years. In the round it was a stupid thing for a 20-year old to do it, but if you are going to do stupid things then you should do them wisely and not pay over the odds for it, 0% is about right ;) The second was a personal loan to buy a car off a family member as they were changing it, which I discharged in six months, another piece of moderate folly in my twenties, but I ensured I could pay the loan before applying for it, which seems to be a detail a lot of people miss these days.

    Maybe the grizzled form of my future Self is in the process of building a time machine to go back and have a word in the ear of the young Ermine, because I stopped borrowing money to buy consumer durables after that, with one ghastly, stupendous and horrific exception, buying a house. By staying put I passed the criteria of the first box, but only in retrospect. I even borrowed my deposit for that on a 0% credit card deal, but at least I didn’t lose money on that, because I paid it down before it fell due.

    That’s the long story of why I don’t trust Zopa at all, and will probably limit my exposure to that to my original stake. They lend money to people who shouldn’t be borrowing it for the purpose they’re using it for. I took a butcher’s hook at what my borrowers were borrowing for

    1. Car
    2. home improvements
    3. consolidate debt
    4. car
    5. other
    6. car
    7. car
    8. home improvements
    9. consolidate debt
    10. wedding expenses (total of £7500! though only £10 from me, thankfully Yikes!!!!)
    11. Consolidate existing debts
    12. car
    13. car
    14. car
    15. Car
    16. consolidate existing debt
    17. car
    18. car
    19. car
    20. car
    21. car
    22. home improvements
    23. holiday (£5000, jeez!)
    24. home improvements
    25. car
    26. motorbike
    27. car
    28. car
    29. caravan
    30. home improvements
    31. car
    32. car
    33. consolidate debts
    34. home improvements
    35. home improvements
    36. car
    37. car
    38. home improvements
    39. consolidate
    40. home improvements
    41. home improvements
    42. car
    43. car
    44. consolidate debt
    45. car
    46. car
    47. car
    48. consolidate
    49. car
    50. car

    Now if you look at this lot it’s a fairly sorry story. Why are so many people over their 20s borrowing to buy cars, FFS? There are people my age at it, you are actually meant to learn something as you go through life. A car is a known running cost – they wear out and break down after you’ve had them for 10 years, so when you buy one you start saving every year 1/10th of the price so you have enough to get the next one. The price of secondhand cars actually drops – I paid about £5000 for my last one, a VW Golf which I had for 13 years. I could get a great s/h car for £5000 nowadays, and £5000 is worth less now than it was 14 years ago. I’d probably look at paying less, because to be honest I just don’t need £5000 worth of car.

    zopa loan purposes

    what people are using zopa loans for

    We have 8 debt consolidators in there. These guys aren’t going to pay that back – if you’re borrowing money to service debt you are in deep shit and going deeper. I hope the girl who’s borrowing £7500 for her wedding won’t have the shine taken off her marriage by the stress of paying that lot off. The summary is scary, because only the home improvements one would pass the Ermine’s beady eye in the test above, and that is for improvements, not Changing Places fun and games or new carpets because you’re bored with the colour of the old ones. Not if you’re borrowing money to do it, because that is telling you that you are living above your means. I have some sympathy for the people in their 20s – stumping up the money to buy a car to get to work may well need borrowing money. But there are a lot of people whose age indicates they should have got out of that stage…

    I feel a lot better about lending the Nationwide cash at 5% than doing the same for Zopa customers. And yet Zopa seems to have a strong following in the UK personal finance community. I have to say that if I were these Zopa customers’ bank managers I’d give most of them short shrift ;) I’m sorry, but if you are over 50 and borrowing money for a car then you need to start buying less car. Mr Money Mustache gives it to you straight between the eyes in his usual inimitable style. Basically you do not need a pickup truck, and SUV or a people carrier to drive to work or take the kids to school.

    Notes:

    1. it’s come to my attention that there is a whole wedding industry whose raison d’etre is to make sure newlyweds start their married life in as much debt as they can persuade them to go into. On the ads they say getting married is all about the wedding and the honeymoon. For crying our loud these good people state that

      Your wedding day should be the most romantic and memorable day of your life

      I guess what they’re really saying is it’s all downhill from the end of the honeymoon, eh ;) When you look at people who have been married a long time they didn’t need some ghastly extravagance to get married. It was about each other, not about their consumer purchases. If anything, going into debt to get married is more threatening to the  relationship than not having an expensive wedding in the first place. Get your priorities right – being stressed about owing money is no way to start a life together if you can avoid it.

    2. not paying rent is not a great thing in itelf if you have to tie up a load of your capital in an illiquid asset like a house. There’s nothing fundamentally wrong with paying rent, if it costs you less than you’ve have to invest in buying a house and all the ancillary parasitic costs of home ownership.
    29 Jan 2013, 12:33pm
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  • A look back at three years of a high yield portfolio and a look forward to 2013

    MarkyMark’s got it right – January is a long cold month of introspection.  It’s time to look at my stock portfolio and ask myself – is this working for me of where things have gone, where they’re going and all that. The standard mantra for stock market investing is you should buy an index fund and sit on it. That’s probably a good way to save for retirement, but I want an income from it, and I am awkward and different anyway. Doing it in an ISA makes it easy to ask the fundamental question that a stock portfolio ought to be able to answer.

    Would I be better off in the bank?

    To answer that question I have to ask myself the question

    What steady rate of interest would a bank have had to offer me, on the money I put into the ISA and at the times I put it into the ISA, so that the total return + capital value is the same as the total value of stock + cash in the ISA?

    Now it’s not necessarily a fair question to ask of a high yield portfolio (HYP) that’s been running for a while 1 – but in some ways it’s a fair question to ask of any stock portfolio. Because I switched  ISA provider I don’t have the details of when I contributed money, but I do have the information of the total amount I put into it in any year in a separate spreadsheet.

    It’s also not the question many people ask of their share activities. It’s easy to look at the winners and pat yourself on the back, which quietly ignoring what didn’t go so well.

    Success has many fathers yet failure is a bastard.

    Using the total gets round that problem, as it automatically integrates every share and every transaction cost, wit one exception. That’s what it would cost to liquidate the portfolio and turn it back into cash. That’s about £12.50*15 which knocks about 0.5% off the total, but I’m planning to live off the income, not sell up, so I’ll ignore that.

    I modelled this in Excel, assuming I put the total ISA amount into a bank at the beginning of the relevant year and they paid me interest at the end of the year, which obviously adds to the stake for next year. It’s an overestimate of what actually happens. I try and spread myself across the year, but I am an opportunistic ermine, I’ll hit it harder and earlier if things like the Summer of 2011 happen.

    last five years of the ftse all-share

    last five years of the ftse all-share

    The first thing is to take a step back and look at the big picture. I started in April 2009 so anybody can be a shit-hot stock market investor in a rising market with a 20% uplift from the start ;) An FTAS index would do nicely, though not as nicely as you would think comparing the April 2009 value and now because I wouldn’t have bought three and a half years’ allowance all in one go.

    The capital gain is 7% and the divi gain is 8% of the current value. I calculated capgain by taking the appreciation on total cash put in and subtracting the sum of all dividends paid over all time. Since it’s run as a HYP for about three years one would divide those gains by three years to get p.a. returns and then compensate for the fact the stake was less for most of the time.

    The proper way to do this is using XIRR but I was lazy so I set Excel up to run a parallel simulation of a bank account with the periodic ISA cash added, and  scaled by a nominal interest added annually. I then fiddled with the interest value to get the end result to match the total value of the ISA. To do that a bank account compounding at  8% p.a. was the answer, it’s 9% now.

    It all doesn’t amount to a hill of beans because of volatility in the capital value

    I started writing this post a couple of weeks ago. What’s been clearly apparent in the ridiculous January rally we’ve had this year is that this isn’t the right way to do this job. I’ve just recalcuated this (29/1/13)  and the figures are 9% and 7%, because the capgain has gone up but nobody’s paid me a dividend in the last couple of weeks. Which is good in one way, but a bastard as far as making sense of what’s going on. When I started writing this I thought integrating over three years will smooth the peaks and troughs enough to get a long view. It isn’t. Because the capital value even of a HYP is 20-25 times the income, variations in the capgain dominate the result, and these vary directly with the market. The sheer amount of uncertainty and noise this imposes upon the outcome makes it impossible to draw any meaningful conclusions from the question what rate of interest a bank would have to offer me to match the current outcome. However, the alternative, looking at the stability of the dividend income as a proportion of what I contributed, does provide some support for the reason I started down a HYP path.

    The other bugger is that it’s hard to tell what inflation is these days. The Bank of England tells me inflation averaged 5% a year 2009-11 – they don’t go as far as 2012 yet. They do, however, use the infernal CPI measure, and RPI is closer to my experience of inflation over the long run.

     

    RPI: Index level, All items, monthly, UK from Timetric

     I was pleasantly surprised to observe it wasn’t quite that bad. So do I knock off 4 or 5% for inflation? As such I am a little short of  the design spec of a HYP – to yield about 1/20th of the capital value while increasing the capital by about inflation. Like anything in the messy real world I won’t take away from that that this will go on forever, but at least it is integrated over several years. The lower volatility of income relative to capital is already apparent. The total figure also includes all trading losses and losses associated with some foolishness three years ago with BP and Barclays as I reminded myself why I am a rotten trader and before I stopped that ;) Some of that foolery cost me performance, but it will slowly fade in significance with time. It is notable that most of the churn has dropped away.

    I did calculate what that was equivalent to as a daily compounded rate which is what my cash ISA is  but for 8% it’s not different enough to show.  That’s about the same as The Accumulator’s Slow and Steady portfolio over the last two years. I’m not sure is TA has done the bank account simulation or calculated the XIRR so I’m not dead sure I am comparing like with like. I was going to use index funds to benchmark this until iii kicked me out but TA’s results will do this job for me.

    If I were living off this HYP the divis are real and can’t be clawed back, whereas a growth portfolio is still all at risk in the market. I have to actively stick my winning chips back into the casino ;) That subtle difference is what I like about a HYP. I am still sticking the chips back, because I don’t need the income now.

    I don’t aim to sell. Once you have about 20 stocks (I haven’t yet) you can let a stock go down the pan every few years, if that really is the price of inaction. None of mine are anywhere in this position. I found Kirby’s article,  and Monevator‘s original HYP article, and Legg Mason’s article, and my Dad’s experience compelling enough. Curiously, in his latest article, Monevator talks about selling criteria, while acknowledging

    I also have no trading strategy because I’ll make it up on the hoof. In my view, once you’ve decided to go to the dark side and buy individual shares rather than passive funds, you must do it your way. I believe active investment is at best an art not a science (at worst it’s an illusion) so no firm rules.

    I think he’s looking at the wrong end of the telescope here. The aim of a HYP is not to sell. However, you do get to choose when to buy. Valuation may illuminate that decision. Last year I have had a watchlist of potential HYP share candidates, and got iii to email me if the value of these shares falls below a certain point. They emailed me about BBY which I had selected as a candidate, partly because I have nothing in that sector. Last November BBY has a poor interim update and the share price dropped below the trigger point. I took a look at what was up, but couldn’t actually see how the firm was about to go bust, or generally why people were getting their knickers in that much of a twist. So I had some of that, and it’s done well since. If you’re going to buy and hold for dividends, what you pay in the first place matters. I took some learning from RSA, who at least I am square with now – the loss of capital is counterweighted by the accumulated dividends.

    That method is not foolproof. I can be more fool that the system is clever. AGK doesn’t even fit into the HYP metrics so it really should be considered as a rush of blood to the head. I can afford the odd thing like that. Not too many – about one a year is OK.

    Targeting firms on my watchlist when they go down, evaluating why and taking a view on whether it is serious or not has helped with adding to existing holdings earlier. It worked on NWBD when I added a lump to the existing holding for less than I paid the first time. To my puzzlement a share I bought for the 10% yield is actually higher on capgain than it’s paid in dividends. This particular sort of share would be expected to depreciate in value over time as it’s fixed interest so I don’t know what’s up with that capital gain. Perhaps it will disappear in the mythical recovery that’s been a year round the corner for the last two years. So what. It’s up to other parts of the HYP to do the heavy lifting then.

    Sod determining selling criteria I say. It’s buying criteria you need for a HYP. For instance I observe some of RIT’s cogitations on the valuation of the S&P500 in terms of CAPE10 because I need some global diversification. At the moment the conclusion is the time is not right, hopefully Obama and the GOP will get into a good old hissy fit and have a punch-up about raising the debt ceiling and drag it out long enough to get into the start of the new ISA year. Because I know jack about the US market and it would be dear for me to buy individual shares I am fine with an S&P index fund there, or perhaps a Dividend Aristocrats fund which is more in keeping with a HYP. At the right price, which is about 2/3 of what it is now unless earnings rise. And I’m still after a Grexit, though the way  things are going we will see a Brexit first. Which should be kind of interesting, in a Chinese proverbial way. Possibly useful, too.

    Inflation

    Inflation is the endless concern. I have a fair amount tied up in cash, and inflation is busy at work destroying the value of it. QE is working through the system and this leads to inflation, effective £ devaluation and is a positive for the stock market.

    I have too much in cash, and need to reduce the exposure to a falling £ which will destroy the real value of some of my networth. In my pension AVCs I may re-enter the market with the L&G global index fund with half the capital, even though I will probably call on this is in less than the five years that people normally say is a minimum for share holdings. I may hedge half my remaining cash holdings in an evenly balanced (at the outset) mix of USD, CHF, CAD, AUD, CNY using IG index. There are running costs associated with that, however, and various other issues.

    I also hold cash for the usual emergency fund purposes and an extra lump for a flat roof, because a flat roof lives on borrowed time as soon as it is made. You must never take a risk with an emergency fund, so most of mine is lodged with National Savings and Investments in their ILSCs which offer a tax-free RPI uplift to stop it dying slowly. Plus some in a Cash ISA for liquidity, which unfortunately is probably about 5% less valuable than when I opened it, and in future decades to come the combined two years’ worth of Cash ISA allowance will probably buy me a packet of peanuts and a pint of milk. There’s not much one can do about that sort of thing, and the sensible thing to do would probably be to add it to my S&S ISA. Perhaps in that mythical recovery it will be possible to get a decent return on cash. Unlike some I don’t expect a real return on cash, just going back and finding the same amount of real value as it was when I put it away will do me fine.

    You save for liquidity and invest for return. The deal used to be that you get a paltry return but no depreciation for liquidity and a long-term return but short term risk and volatility for investments, but at the moment the cash/liquidity depreciates dangerously. Turn your back on a lump of cash for five years and you’ll lose a quarter of its real worth.

    The tribulations of a falling currency

    Most people first notice a falling currency when they go on holiday, and then they notice it in a delayed way as the price of everything slowly goes up. Just look at the innocence of the sleight of hand applied by Harold Wilson

    [iframe http://www.youtube.com/embed/mIQnpoGBS1I?rel=0480 360]

    And people believed him for a while, FFS! Of course, the Britain of 1967 actually made stuff, and probably grew some of its own food and mined its own coal, which generated power, was turned into gas and heated homes, so Wilson has a small point. Unlike the Britain of 2013, which does none of the energy things and is depleting the oil bonanza that enabled it to stop doing those. The FT made the case in 2008 that the pound is experiencing a step-change down and it looks like the process is continuing. If you hold your wealth in cash denominated in pounds, it’s been getting worth a lot less over time.

    There’s not much most people will or can do about that. Investors holding equities or land, or real stuff, even, though I hate to (cough, splutter) say it, property, will experience less of that effect.

    However, there is a nasty insidious effect of it. They will often tend to become poorer investors. The falling pound will make them believe their stock-picking or asset selection is shit hot, and confirm existing biases. I did well with my HYP. So what. It was nothing that special. Everybody had a stonking run in 2012. Were they all brilliantly clever? Or did the rising tide lift all boats, and more to the point, is there an earthquake under the beach lowering it – the value of what they are measuring their success is draining away as the endless rounds of quantitative easing destroys the yardstick they are using as a reference.

    Macro issues for 2013

    On the macro upside there is less worry about Eurogeddon, which probably means it will happen this year while everybody is looking the other way. I was buying a HSBC European index fund regularly and have been most pissed off to see it gradually rise, as I expected to buy into increasing Eurogeddon. I don’t have the chutzpah to actually buy GREK. A lot of this, of course, is the creeping death of the pound, I’m not that sure CPEI has done anything to justify its 17% rise on purchase price, other than to sit on its backside and watch the £ devalue somewhat, abetted a tad by hedgies thinking less unkindly about the euro than the pound.

    The US still owes a shedload of money, and the polarization to the political scene there will probably lead to a suboptimal fight about that. The narrative is better told by Dr Doom himself in the Grauniad, he is predicting (wait for it) Doom in 2013.

    On the non-financial front there’s the forthcoming bombing of the Iranians by Israel and associated punch-up and oil spike/new plateau. There are fifty shades of shit going down in Arab nations and various messy bits of unfinished business left behind by the Project for a New American Century who seem to have gone into suspended animation in 2006, presumably to work out why it all seemed to go wrong.

    There is globalisation in general, which is making it very hard to work out what a life well lived and how to fund it looks like in the UK, particularly to those starting their working lives. On the upside they have better technology, better communications, better health, and can look forward to a much longer life that those that have gone before. On the downside they are in a jelly-like unstable world that makes it hard to get set right in the beginning, and they must continually adapt to roiling change, and the relative decline of the status of their nations relative to the rest of the world.

    It’s not a cloudless horizon, despite the euphoria in the stock market.

    A HYP rather than a passive index portfolio.

    So many PF blogs consider the non-rational the enemy within. Psy-Fi has a long list of irrational ways people can give themselves the shaft and there’s a tightened up version on Monevator. I’ve always felt a little bit uncomfortable with that perspective, in a sort of yeah-but way. The trouble is that saving for the future is also irrational – you have to go without now. There is no objective value to be placed on an individual’s future value of money, what’s right for you isn’t right for me. Doing without £1000 in real terms is a damn sight easier for me now than it was when I was 25 or 35.

    Petra Ecclestone. nlike you or I, sh doesn't ned to earn the money to put into her investments

    Unlike you or I, Petra Ecclestone doesn’t need to earn the money to put into her investments, net worth $300,000,000 apparently

    Unless you inherit your wealth like Petra Ecclestone, you have to save it from earnings to get your foot in the door. It’s crystallised life energy you have to save, the result of precious years of your life surrendered to The Man, and you have to save a lot to actually shift the needle on the dial – your target income * 20, to a first approximation. Saving £500 or £1000 here or there ain’t gonna cut it unless you do it regularly for years. You need nearly six figures just to match JSA, and there are enough people out there saying that’s not nearly enough to do anything with. You need £150k to save enough to pay yourself the basic State Pension of £140 p.w.

    Over a 40 year working life that is still a big ask – compound interest will help but it probably won’t double your money, and a hard twist of fate means that you will usually be able to save much more in your later working life than when you start out. It was the power of irrational fears that made me save more than the ordinary. So I am going to raise a glass to the unquantifiable world of values, and why you do what you do. Eliminate behavioural biases where you can, but deep at the heart of much of the malaise in the West is the search to paint the world by numbers alone. Oscar Wilde was right when he poked fun at people who know the price of everything and the value of nothing. This is about values. I couldn’t honestly say to someone about to start work that saving for a pension is the rational thing to do.

    Many young people take the same approach as the Lotus-Eater, and to be honest, I think that’s probably the most rational thing to do, because of the unknowability of the world in 40 or 50 years’ time, and the absence of a secure store of value over that sort of time period. I would be surprised if this sort of thing didn’t happen somewhere in the West in the intervening time. I knew someone from Germany personally who had lost their life savings – twice, in things like that. It was the ownership of land, and a more stable human network of connections of the sort that we have deliberately eliminated in modern societies in the search of equality that meant she had anything left.

    Capitalism just does that in combination with the frailty of human societies. Every few generations it has a massive hissy fit and destroys shedloads of worth, value and promises of future gains. Just because it can. This isn’t Schmupeterian destruction, it’s just capitalism amplifying the madness of crowds. It seems to need to do this every so often, because it is not unconditionally stable, and there is no generally accepted external reference point that will hold its head while all around are losing theirs.

    and so the cycle will turn again, and start anew

    and so the cycle will turn again, and start anew

    Eighty long years have rolled by since the 1930s, and people built firewalls and distant early warning lines against it happening again. Only seventy of those needed to pass before Bill Clinton had so much cock that he saw fit to repeal the Glass-Steagall protections that held some of the demons at bay. Let us assume that we find a way to stabilise and set in train protections against what happened in 2007/8/9. I will confidently predict that even if all the other macro hazards to humanity are avoided, when the young people entering finance in their twenties over the next few years have reached their eighties and nineties, those protections will have been weakened, because they get in the way of Progress. And so the cycle will turn, and start anew ;)

    I use a HYP for my shares, rather than index-tracking. Why do I do that? Poor old Monevator is scratching his head on there wondering what’s up with people

    I am not saying they are right to find index funds distasteful. I am saying I have met many people who do, and I have failed to convince them otherwise.

    Index funds have their place – even in a HYP I will use them for markets and areas I know little about or can’t access economically. Here are some reasons and gut feelings it doesn’t convince me across the board. Some of them aren’t logical, and I am perfectly prepared to pay the price of that.

    • First and foremost, the whole living off the income thing. Most people are building a retirement fund over decades, and the yearly value doesn’t matter other than to their sleep patterns. I have about 8 years, and probably less, to start living off the income. I’m not rich enough to accept the returns on passive index funds and I have had bad experiences of income volatility from things like IUKD that aren’t passive at all though they look it. If you want income early in your investing life, you fly this damn thing on manual or you do without the income.

    The first point is a reason, and a compelling one against using index funds, IMO, because of my atypical situation of a short horizon that can live with market risk, because I have defined benefit pension savings elsewhere. The others are prejudices ;)

    • It didn’t work for me in the early 2000s. Obviously there’s sample bias there, after all the 20%  gains I made in my AVC fund using L&G’s Global index are a counterfactual. But the alternative was cash in a devaluing background of government money printing QE. ’nuff said. Most of the gain there was due to the government devaluing Sterling 20% by printing money. In many ways saving money from the depths of a global financial near death experience while the government is doing its damnedest to destroy the real value of money and the real value of its debts is the canonical sort of thing index investing is designed for. The Telegraph is full of old buffers who don’t get this. You don’t fight governments, you try and roll with the punches they throw. They are the 900lb gorilla and you aren’t, unless your Warren Buffett or the Rothschilds and even they aren’t big enough to fight the Fed. It all involves risk and nothing is for sure in this world, though cash melting through your fingers in the next few years is as close to a dead cert as you can get. If I have any cash when we experience the next crash I will do the same. You don’t need to think about investing from that sort of base, you just need to do it. Pretty much anything will do, and in the fog of war at least the index is unlikely to go bust.
    • One day, Vanguard will have its rogue trader or internal thief. Money is power, and power corrupts. Why did Al Capone rob banks? Because that’s where the money was! I may buy some Vanguard Lifestrategy as part of my portfolio because it will form only part of the whole, but a whole 100% Vanguard index portfolio with nothing else? Do you feel lucky, punk? Other firms do index funds too, sometimes you hafta pay a little more TER for the insurance of provider diversity ;)
    • The backstory. What exactly do you get when you buy an index fund? I own a small slice of DLG, BBY, GSK, NG., RSA etc. I know what these guys do. I can see their boots on the ground. Some build houses, some write car insurance, others make pills. What does the FTSE100 index do? Six years ago it was banking. In 1999 it was tech. It was oil recently. I can’t relate to that. The index fails the Henry Kissinger ‘Who do you call’ test.
    • I like dividends. They slowly buy me out of mistakes. They give me an income without having to sell units. Although intellectually I can understand profit comes from capital gains and divis, selling units feels like selling down capital. In a multifund ISA, selling units forces me to make decisions about which holdings to sell. I hate that. I need more dividend yield than that on most indexes.
    • Track record. It’s worked well, particularly for people who were catatonic and sat on their hands!
    • Index investing is passively active by definition – it is rebalanced quarterly by the index. A true HYP becomes unbalanced (unless added to each year). I am beginning to wonder if that is such a bad thing as it’s made out to be, since the unbalance comes from success – if it all comes from failure you’re gonna be dead anyway. Say an HYP designed in 1980 held the minnow MSFT. Should it have kept selling the swelling behemoth?
    • A HYP that has cash added to yearly can try and balance sectors with the added money. That’s probably good diversification (indirectly pushes you to buy low). It’s also a perfect fit for an S&S ISA. Kirby’s 1984 article leads me to suspect actively selling parts of a steady state HYP to rebalance isn’t necessarily good diversification. This isn’t going to be a problem for me for a few years yet. Next year’s annual allowance is 20% of the total, which is plenty of rebalancing. Although that percentage falls, the divis start to help out with rebalancing until you start drawing from the portfolio.
    • A multi-decade HYP will integrate several business cycles, and see a lot of inflation. It’ll see different sectors skyrocket and pan. So what? Watching the world go by is what old money does while pursuing its other interests, all the time collecting the rent.

    However, in other respects I pretty much run like Monevator‘s approach. Sit tight. Do as little as possible. Yes, I’ve had to deal with corporate actions like NG’s rights issue shenanigans. Paradoxically I had to sell some index funds when iii threatened to start charging transaction fees on those, other than that I’ve sold n’owt since going HYP, with the exception of a slug of Direct Line’s IPO. There I had to pitch for more than I wanted because of the risk of getting knocked back, selling the excess at a modest gain.  As it is I still have too much insurance and no oil firms or mining. The latter seem to be having a little of a hard time at the moment which is good for me if it carries on to April (my ISA is maxed out at the moment). I reinvest dividends, and shall continue to do so until I have no free cash left to live on or I start drawing my pension. In the latter case I will continue to reinvest dividends, because I maximise the tax shelter and I expect governments to get extremely rapacious in tax terms if and when there is such a thing as a recovery. They got a big hole to fill. The more tax-free incoem I can build up the better I can hold the line against these depradations.

    I’m happy with the return and the balance between dividends and capital gain. The steady improvement in the dividend income over the three years is good, it’s now enough to make a significant and tax-free addition to my future pension. I’m still less than a third of the way through my journey building this portfolio. As I get into the second half in a few years’ time I will probably shift to a index approach for that, because  diversification works, and there’s no reason not to apply it to investment philosophy ;) I just didn’t want to start with an investment philosophy that bores me and has failed me once before.

    Notes:

    1. the reason is that a HYP is designed to pay the income, not save for a goal like uni fees or retirement. Its key metrics are do you get the expected income, is the variation on that income acceptable and does the income track inflation in the long run. The total value of the portfolio is not a key metric, if the income is good enough then the HYP is good enough
    20 Sep 2012, 11:43am
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  • the redeeming value of sitting on your hands and doing nothing in the market

    Here you go, an opportunity for a laugh at the Ermine’s expense ;) There’s been one persistent dog in my ISA portfolio listing, Royal and Sun Alliance (RSA). There’s nothing particularly wrong with the company, but everything wrong with when I bought this share.

    RSA stock price chart

    Take a gander at the chart, and see if you can guess when I bought this. Yup, February 2011. I didn’t exactly hit the peak, but near as dammit. So this bad guy gets to look like

    In a previous life I’d have hated that SCREAMING RED You Screwed Up reminder, and be tempted to hit the conveniently placed sell button next to it in the portfolio form. So tempting, and yet so likely to lead to the sort of investment death that Pete Comley grouched about in his Monkey with a Pin book. With a growth share you just have to sweat it out or take the hit, there’s no Third Way.

    However, this was after I’d taken a decision to become more catatonic, though not in the classical way. I could’t see anything that had hugely changed about the company, so I left it to fester. It was down about 30% at the low water mark, and even now it’s 15% down.

    However, there seems to be a hidden benefit of a HYP in that there is a Third Way, compared to a growth portfolio. Firms that have a reasonable dividend paying history

    RSA dividend history

     

    which is part of what attracted me to the share, have a useful attribute. They slowly buy me out of mistakes like that. We always look at share price graphs, but since I own this stock my own representation of it does show the dividend return as well. Note I use monthly beginning values for the stock valuation graph otherwise Excel would consume all the memory in my PC, so it doesn’t show the price spike I bought on. I paid about 3100 in all for my share of RSA, including commission etc. Yeah, that was dumb. Presumably in Feb 2011 it looked to me like the recovery was well underway, or something just caused a rush of blood to the head…

    RSA valuation (monthly chart) stacked with the accumulated dividend I have got on my stake

    Now I still haven’t broken even on this, but I am £100 down on the purchase price, not £400. And RSA are slowly buying me out of my cock-up. It was still a mistake to buy the share when I did, but it shows the value of doing nothing. This is the only line of stock in my ISA that is down on a total return basis, though that’s easy to say at the moment when everything is riding high. And we should remember that the reference point, the numerical £ value, is being destroyed by Government action all the time…

     

    ISA valuation + cumulative dividend return graph. Note this is NOT a performance graph, most of the accumulated rise is because of purchases! I would be working for Goldman Sachs if this were a performance graph ;)

    It is instructive of plot all of the holdings in my ISA on a stacked chart, pinching the idea from Rob’s chart wrangling. Unlike his performance chart my chart shows the total value of the ISA over time with dividends added in. The vast majority of the change in value is due to putting money in and making purchases. What is visible there is that the dividends make an increasing proportion of the whole return for a stock as time goes by. This isn’t stupendously visible because my ISA is only three years old, though you can see that the small gaps are larger on the lower stocks that I purchased earlier; the accumulated dividend becomes a larger and larger part of the total return as time goes by. To make that clearer I’ve split this into capital value and dividends received

    capital value and accumulated dividends

    Because I am putting money into this the capital value will increase faster than the dividends, and will do for several years. In theory once I get to 200,000 in 17 years the dividend income will match the rate of addition and then outstrip it, but I haven’t got that much cash for this ;) Nevertheless, the dividends have put in a decent 8.5% of the amount I have contributed so far. There’s no sense in extracting the cash from the tax-sheltered account while I still have cash outside, so this state of affairs will carry on for a few years.

    Although theory says a growth portfolio is equivalent, given an equal amount of risk, where you take the income if needed by selling off parts of the portfolio, being able to live off the income feels better. It also reduces the amount of decision-making. It is more expensive to sell off 2% of the portfolio by selling 2% of each holding as opposed to one stock to match 2% of the total value, but then which stock do you sell?

    It is clear that Slater had some point in that ‘elephants don’t gallop’. HYP stocks are mature firms in the Summer and Autumn of their life cycles (the Winter ones are the value traps ;) ) The wildest party thrown in my HYP is the recent BAE EADS fuss, which is hardly a ten-bagger…

    I had to leave out National Grid form the plot because I couldn’t see how to represent the corporate action a while ago. I’ve put 28k into the ISA and TD list the capital value of the stock as £29k. However, neither TD’s summary or the chart allow for the £1500 cash in the account from a motley collection of the dividends that haven’t yet been reinvested. And a fair amount of this year’s allowance hasn’t been added, because it might as well earn me some paltry interest outside the ISA; I haven’t had much taste for buying this year or indeed the opportunity, since it took three months to shift my ISA from Interactive Investor. So the current snapshot return is about £2500 on an average stake of £14000, over a period of three years. The actual amount of dividends I have received is £2400. The yearly dividend rate as a proportion of the total invested by the end ofthe year was only 2.5% in the first year but shifted to 5% as I moved to a high-yield portfolio approach.

    The trouble with this is not the rate of return. It is the £10k p.a ISA limitation – it takes time to pump up an ISA enough to win a useful income from it, and that income only rises at about £500 a year. Wannabe early retirees take note; if you want an ISA to form part of your income stream, and possibly allow you to go for a late pension savings burn then you have to start early, like at least ten years before you want to retire! In the interim I have to use unwrapped holdings and cash. There are people like Bernanke and our own government desperately debasing the currency and falsifying the inflation figures at the same time, which makes the cash not in NS&I ILSCs a toxic non-investment horribly exposed to government confiscation by stealth.

    There’s also a lack of opportunity in the froth, I’d like another stock market meltdown like last summer, please, just without the rioting, thanks all the same. The Euro and Grexit don’t seem to be delivering yet – heck I am slowly building up a European Index position and it is running away from me rising which is not how this is meant to turn out. Mind you, there is the upcoming oil war on Iran to add to the mix, so the meltdown will probably appear in the near future. And October is coming up, often a good month for fear and loathing on the stock market :)

     

    30 Dec 2010, 3:37pm
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  • Seeking Shares for income in 2011 – this was easier in 2010

    Unlike investors saving for long-term growth, I want income, and over a specific period between 2012 and 2015, between when I plan to leave work and before I draw my pension. I’ll draw it somewhat early, to reduce the annual amount.

    The reasoning is that a pension is taxed as income, so if I can build dividend income to top it up in my ISA, drawing the pension early and lowering the annual amount keeps more of my income below the tax threshold, hopefully £10000 by then. It also lets me stop working earlier, which is all to the good,  and I can make up the difference with the income from my ISA, which isn’t considered as income (though note that dividend income is already taxed at source in the UK)

    I expect the government to be rapacious in clawing tax from as many places as it can as it fights the economic headwinds, and I want to do as little as I can to help them. Hence minimising income and maximising tax sheltered stuff.

    Because of this short time scale I am seeking income, not growth from my ISA, though obviously at the moment I reinvest the income to maximise my tax-sheltered stake.

    The trouble is that there is much complication. I target a yield of 5%, and it is hard to get enough diversification in an ISA using individual shares in a high yield portfolio. I try and keep any purchases in my ISA above £1000 and prefer lumps of £2000-3000. By using the grouping function of my ISA provider I can get trading costs down to £1.50 Since you can put at most £10,000 a year into an ISA, if I focused all my ISA as a HYP I would be woefully undiversified for a long time, accumulating 5 different shares a year.

    Investment Trusts – diversification for a smaller stake

    That is short of the required 15 according to TMFPyad or 20 according to Monevator. This year I cheated and used an investment trust, Merchants Trust, which I bought in July when it was at about a 5% discount. I bought a reasonable stake in it, MRCH is about 30% of my ISA, and planned to carry on purchasing similar sized lumps of another IT, next one around this time of year.

    I fund my ISA from saving from earnings so I can’t load up at the beginning of the year as you’re supposed to. Plus I get some temporal diversification in buying through the year, which in a world of bear markets and double dips is no bad thing.

    However, on looking at the investment trust market I observe that clearly I haven’t been the only person with this bright idea and I’d now have to pay a premium for most income investment trust including all the ones on my shortlist, so that idea has now been stuffed. I’m obviously chuffed with my existing investment in MRCH and that can stay right where it is, it’s just a pity that I didn’t get some more at that price.

    The DIY High Yield Portfolio (HYP)

    So I have to look again at doing this HYP job for myself. Upside is no annual management charges, but the downsides suck, big time. They include that inherent lack of diversification to start with, the fact that I don’t have an illustrious career behind me as a stock-picker (I was hammered in the dot-com bust), and that the whole thing is a somewhat mapless territory. I really liked the investment trust route, and hopefully NAV premiums will go away.

    However, I have to deal with the world as it is rather than how I’d like it to be, so some study of the theory behind a High Yield Portfolio is in order. I fully expect the double dip recession to return at some time in the coming year, which is good for share buyers though toxic for the value of a HYP. It may not be as toxic for the income from the HYP, however, it would be nice to see an analysis of that…

    Real Estate Investment Trusts

    If diversification were my aim, one class of investment I have no exposure to is commercial property. I hate anything with the mention of property in it as an investment – I sold the first house I bought at a 40% nominal, probably >50% real loss. Property is a dirty word all round for me. Let’s look at what commercial property is (the REIT I am considering is BLND)

    It’s retail parks, warehouses and a lot of office space in London. Well retailers are going to do really well in the coming year aren’t they, what with VAT up, taxes up, Internet shopping up, punters squeezed on all counts. They’ll take an occupancy pasting in 2011. Office space in London, conversely, I feel okay about. The bankers will moan about relocating the top brass to Zug but they’ll still employ grunts in London.

    Then we have the financials – unlike anything else I have ever seen. PE way down at 4-ish (I normally like to see that below 10 but have never seen anything below 5 that isn’t obviously dodgy) dividend cover way up at 5, yield of almost 5% (nice, I like that) and a decent dividend track record though the distribution frequency has changed from 2x a year to 4x.

    There’s much to be said for buying something that the market hates, and that PE screams that the market hates BLND (and its stable-mate Land Securities which have very similar metrics) with a vengeance. I haven’t yet discovered why. Obviously the prognosis for commercial property isn’t that great, but it looks like these guys can eat a serious drop in rent income and still keep the lights on. And I do like that yield, so I am tempted.

    I need another high-yield share around now and AZN comes to mind, yield about 4.5, PE about 10 and dividend cover of more than 2. And a very respectable dividend growth history. I already hold some of them as 3% of MRCH, the obvious competitor GSK is 7% or MRCH

    All in all this whole HYP is a drag to try and do myself, but I can’t hang around in cash waiting for IT premiums to fall as I can’t call when the second dip will come along. So what I will do is build a HYP over the long term, accepting that I could get hammered by the lack of diversity in the early years, and divert my savings to ITs when they look good value.

    That way the IT approach will give me the security of diversity, but I will still be able to build up my income when Mr Market is offering a poor deal on investment trusts. I don’t see a bull market turning up at any point while I am building my stake, which is when Mr Market offers a poor deal on everything.

    Let’s just take time out to remember what the point of all this is, then

    Sometimes at turning points in the year it is good to lift my eyes from the fog of war, and remind myself why I am doing this. I have already missed the boat according to the criteria here (I have been working for more than 25 years). It is also good to take inspiration from people who have managed to escape the rat race, even if it means living very unconventionally.